Leveraged to the Eyeballs
By Arnold Kling
Herb Greenberg quotes from Mark Hanson, who works in the mortgage industry.
75% of Option ARM borrowers make the minimum monthly payment. Eighty percent-plus are stated income/asset. Average combined loan-to-value are at or above 90%. The majority done in the past few years have second mortgages behind them.
Option ARMs were invented relatively recently, so I may have this wrong, but I think that the borrower has the option of making a sufficiently small payment that the outstanding balance on the loan can go up. This is called negative amortization. When you combine that feature with declining home values, you can easily get to a point where the
home value exceeds the loan balance loan balance exceeds the home value. Meanwhile, the borrower may not be able to afford the payments, particularly after they hit the limit on the loan balance.
Anyway, read the whole thing. Mark Hanson seems pessimistic. He paints a picture of home “owners” (I use the term loosely, given how little equity they have–or ever had) leveraged to the eyeballs. Ordinarily, I disagree with doomsayers, but he may be right, particularly for California. I could be suffering from availability bias. I don’t see this phenomenon among people I know. They’ve been in their houses a long time, and they are not living the type of lifestyles that require tapping into housing equity to be sustained.
My impression was that Americans as a whole actually have a lot of equity in their homes–something like 50 percent or more in the aggregate. But I can’t find any recent numbers. There is some quasi-relevant information in a speech by Alan Greenspan. There are lots of interesting numbers, but not exactly what I was looking for, in this paper, by Greenspan and Fed economist Jim Kennedy.
I remember Kennedy from when I was there. One day, I was very tired after finishing (I thought) a difficult round co-ordinating the staff economic forecast. Jim walked in to my office and said that he needed to make a change. He apologized, and said it was his fault. I lost it. “I don’t care whose f–ing fault it is…etc. etc.”
There are not many times in my life when I have gotten so angry with so little justification. As I said, I was tired…
Thanks to Felix Salmon for the pointer.
UPDATE: An alert commenter finds this story.
The amount of equity homeowners hold in their homes slipped in the third quarter to the lowest level on record, just above 50 percent, according to a report from the Federal Reserve Thursday.
In its quarterly U.S. Flow of Funds Accounts, the central bank reported that homeowners’ percentage of equity dipped to 50.4 percent from 51.1 percent from the previous quarter. On average, housing is Americans’ single largest asset.
Economists expect this figure, equal to the percentage of a home’s market value minus mortgage-related debt, to tumble even further as falling home prices eat into equity. It could easily drop below 50 percent by the end of next year, some experts say, marking the first time homeowners will owe more than they own since the Fed started recording the data in 1945.
Home equity has steadily decreased even as home prices jumped earlier this decade due to a surge in cash-out refinances, home equity loans and lines of credit and an increase in 100 percent or more home financing.